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Reader Question: Should I Invest in My Non-Matching 401(k)?

This article was written by in Investing. 8 comments.


Occasionally, Consumerism Commentary readers send in questions about handling their finances. I am not a financial planner, so I have no certification claiming I’m qualified to give financial advice. I am not an investment adviser, so I certainly won’t be recommending stocks. I like the opportunity to address financial questions that other readers may be concerned about, and if I have an opinion or two on the matter, I’d be happy to share.

Readers may disagree with my opinion, or they may agree. Addressing these questions is also an opportunity to instigate discussions. As with any advice you may receive, it’s always good to check with a professional beforehand, particularly if the decision could have significant effects on your financial condition.

Here is a question I received from Steve:

I’m 24 years old and I haven’t started any retirement savings, but I know I need to start. My company offers a 401k benefit but does not offer any match. I was wondering, would this 401k’s tax benefits still be worth taking advantage of over other retirement investment vehicles? Would a Roth IRA be wiser? Or something else?

There are two primary tax benefits to investing in a 401(k) plan. You contributions and earnings grow tax-free until you retire, and your contributions can be deducted from your income for tax purposes if your income is low enough. I describe and explain the 401(k) contribution limits here.

Taxes are a distant second next to the best benefit of most 401(k) plans: matching contributions from your employer. Employers can structure the matching contributions in a variety of forms. One of the most common is for your employer to match 100% of your contribution up to a certain percent of your salary. For every dollar you take out of your paycheck to invest in your 401(k), your employer might also contribute a dollar of its own money. This is an immediate 100% return, much better than what you can expect from any of your investments. If your employer matches your contributions, find a way — any way — to contribute to your 401(k) at least enough to take advantage of the maximum matching benefit. Don’t turn down free money.

The choice to invest in a 401(k) gets more difficult when there is no matching contribution from your employer. At that point, your 401(k) becomes just another tax-advantaged investment account. Unless your 401(k) gives you access to low-cost investments, this account should no longer be a priority. Most 401(k) plans include fund choices that are not as inexpensive as choices you can find elsewhere, like at Vanguard or Fidelity. Low costs correlate to better investment results over long periods of time, and at age 24, this particular reader could be waiting many decades before accessing this money.

You can compare costs by reading the prospectuses for the investment choices in your 401(k) and comparing the expense ratios and other fees with similar funds managed by Vanguard.

Without an employer match, consider maximizing your IRA before contributing to your 401(k). A traditional IRA offers the same tax benefits as a 401(k), and a Roth IRA forgoes the tax deduction for your contributions today for a tax deduction in retirement. That’s a good choice if you expect that you’re in a lower tax bracket today than you will be in retirement. Considering the economy today, it’s probably a good bet that all taxes will be higher in thirty or forty years as the country struggles to pay its expenses, but you never know without a crystal ball.

While your investment choices in your 401(k) are limited, you can invest in almost anything in your IRA, depending on how you open the account. Your investments in IRAs are subject to an annual limit. If you have a strong enough cash flow to schedule your IRA investments throughout the year to the maximum and still have free cash flow, then you should consider investing what you can in a 401(k) without an employer’s matching contribution if your income isn’t above the maximum for taking advantage of the tax deduction. Otherwise, just invest using a taxable (regular, non-retirement) brokerage account. You can name the account “For Retirement” and leave it alone for forty years.

I wish I had been thinking like Steve when I was 24. I’m not sure I knew about the existence of 401(k) plans when I was that age. My employer didn’t offer a 403(b) plan — the non-profit version of the 401(k) — until the following year or two, and my cash flow was so tight, there was no matching contribution, and the investments were so expensive I just laughed. My only investment was in the form of a recently-converted UTMA or UGMA invested with what was probably savings bonds I received as gifts as a kid.

In reality, just making any choice for investing is better than making no choice. Whether you invest in a 401(k), IRA, or taxable account, just the act of putting money aside for retirement puts you ahead of half of all Americans in taking steps to ensure you have a stronger future.

Do you agree or disagree with the strategy outlined above? Share your thoughts on what you might do if your employer were not to offer a matching contribution on your 401(k).

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Schwab Creates Low-Cost 401(k) Fund Choices

This article was written by in Investing. 10 comments.

I used to work for a company in the financial services industry. Another branch of the corporation I worked for is involved with institutional money management. This department manages institutional investments like company retirement plans and pensions. This is a service they provided to other companies of various types, much like Fidelity and Schwab offer 401(k) management and administration to companies. This could be considered an in-house service, so as an employee of the company, my 401(k) plan was managed by this branch of the same company.

You would think that given the company’s standing within the financial industry, the 401(k) plan would include smart investment choices. Unfortunately, most of the funds available are high-priced, actively-managed mutual funds and annuity funds. There is one stock market index fund available, but its expense ratio is significantly higher than those of the low cost index funds found elsewhere. Nevertheless, I wanted to take advantage of the company’s matching contribution — after all, that’s free money — as well as the tax savings, so I relented and participated in the plan.

401(k) plans — and 403(b) plans available to non-profit and educational organizations — suffer from poor investment choices. They are often significantly more expensive than the index funds you can find for IRAs. A fund’s expenses play a significant role in an investor’s ability to grow wealth over time. A low-cost fund could save an investor over a hundred thousand dollars over the course of a career when compared to a similar fund with above-average expenses. Even taking inflation into account, this will be a significant amount of money.

Schwab has announced that they are now offering a selection of new 401(k) investment choices designed to cater to investors who are keen on keeping more of their money in a program called Schwab Index Advantage. It isn’t clear from the announcement whether the available funds will match what’s currently available to retail investors, but if they aren’t the same funds, they should be similar in cost. The Schwab S&P 500 Index Fund has an expense ratio of 0.09%, lower than even Vanguard’s competing retail S&P 500 Index Fund with 0.17%.

The brokerage also offers companies the ability to provide employees with investment advice and planning tools for an unspecified low cost. The GuidedChoice system will help employees make ongoing decisions regarding their retirement investing, and this should help employees save more for retirement. It’s individualized advice, which isn’t common with retirement plans. Most employees are lucky if their retirement plan comes with a web application that helps them determine an asset allocation strategy; individualized advice could, if the advice is good, help investors grow their nest eggs in a way that’s most appropriate for their goals.

Are you satisfied with your 401(k) retirement plan, its choices, and its included advice?

Charles Schwab

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Reflecting on My 2011 Goals

This article was written by in Planning. 13 comments.

A little less than a year ago, I mentioned that 2011 would be the year that everything changes. It’s a phrasing that I borrowed from Torchwood, but it was relevant for me as well as to the television program’s concept. I’ll have more to say about this year’s changes later.

At the time I created my goals for the year, it was difficult to predict how well my business, primarily the operation of Consumerism Commentary, would perform. I had just left my day job to work for myself full-time. It was a decision that I had been considering for several years, once I realized that running a website could be a profitable way to live. On reflection I should have made this change several years ago, as my business has long been able to sustain my finances. I first accepted this fact a few years ago when I moved the nicer apartment in which I live now. It’s not expensive, but it would have been unaffordable with just my day job income.

Even after this, it took several years for me to be comfortable with the idea of relying solely on that revenue. I knew I was in a risky business, and the ability to generate revenue from advertising was shown to be even riskier a few months later.

Without much warning, several other personal finance bloggers lost up to 80 percent of their revenue when the nature of the visitors to those websites changed. Some websites, on the other hand, were unharmed or even benefited, but the risk was never eliminated. When I created my goals and resolutions for 2011, I had risk in mind, but perhaps not as much risk as I should have. Nevertheless, looking back at the past year’s success, one might conclude I was much too conservative.

Income

At the end of last year, I remained conservative when planning for income changes in 2011. I would consider 2011 successful if I increased my income by $100,000 for the year. I exceeded this goal in 2011.

Net worth

I recognized net worth would be difficult to predict when I designed these goals last year. It would be far too dependent on my income, and to a lesser extent, the stock market. I ended the year with about $538,000 on my balance sheet. Calculated using the same method which includes the income generated by the business but does not include the value of the business, I was able increase this number beyond my goal. I will be more specific when I look at my end-of-year balance sheet. I far surpassed my conservative goal of increase my net worth by $275,000.

Investments

At the end of last year when I created these goals, I focused on retirement. As a business owner, it’s hard to know exactly what retirement may mean. When you work for a corporation, it’s easy to fall into the usual expectations for retirement, working for a set number of years until retirement age, leaving your work behind at that time to move to Florida and begin collecting benefits from the government and distributions from your retirement accounts. Working for myself, and particularly working in a business where the future could change at any moment, it’s harder to define what life would be like many years in advance.

Nevertheless, I set the conservative goal of saving 10 percent of my income for retirement. I was able to maximize my contribution to an Individual 401(k) throughout the year while investing regularly in a taxable investment account. Although, I spent only a small percentage of my income each month with no major purchases throughout the year, much of what I have saved is not necessarily designated for retirement, nor is it invested at all.

A couple weeks ago, I met with a Certified Financial Planner from Vanguard Flagship Services, and I have a strategy in place to invest for the medium and long term that’s appropriate for my particular financial situation.

Savings

As I mentioned above, having an aggressively increasing income paired with only modestly increasing expenses helped me build my net worth and my savings this year. With some aspects of my life in flux this year, I decided it was not yet a good time to settle down and purchase a house. This is a decision that is about more than finances. The decision to buy a house, for me, depends on long-term plans for family and career, and these are aspects of life I have not quite yet determined. When I renewed my lease on my apartment in central New Jersey this past summer, I paid for the option to break the lease without penalty at any time, thinking I might have other aspects of my life sorted out before it was again time to renew in 2012. There is still time left.

Savings goals other than a house still rely on other decisions in my life, including whether to have children.

Charity

Throughout the year, I’ve been contributing to my charitable gift fund, a donor-advised fund at Fidelity, that gives me the flexibility to grant gifts to non-profit organizations throughout the year. In the past, I’ve given to a program at my undergraduate university and the non-profit organization I used to work for. This year, I also added a local arts organization to my list.

Photography

As we get beyond the purely financial goals and resolutions, it’s easier to see where I’ve failed. I planned on finding ways to make photography a larger part of my life this year. I’ve enjoyed photography throughout my life, though it’s never been a core passion of mine. That has started to change over the past few years, and I’ve taken several classes to improve my craft. I wanted to dedicate some time every month to gaining more experience, particularly with portraiture. Unfortunately, the success of my business has come at the cost of not being able to dedicate as much time to this endeavor as I would have liked.

Professional photography is not the right choice for me. I would never want to photograph a wedding, and that seems to be the basic income-generating activity for most freelance photographers. I’d prefer to ignore the business aspect of photography completely and focus on creating images I would enjoy. While I didn’t have the time to dedicate to this in 2011, I’m looking at ways to restructure my life to make this more of a possibility in 2012.

Personal health

My health has been on my mind all year. Most likely a result of not having a large lunch in a corporate cafeteria almost every weekday, I’ve lost about five pounds this year. I’m not significantly overweight to start with, but I was definitely not at my ideal weight. I didn’t meet my goal of losing fifteen pounds, so I still have more to lose. The exercise I was getting one year ago was interrupted by a major snow storm from December into January, and it killed my momentum for some time. A few months ago, I joined a gym, and recently travel interrupted my progress.

Getting exercise seems to be more successful with assistance and motivation from a partner, and that’s something I just don’t have right now. All of the above are clearly excuses. The only motivation that matters comes from myself, and if I’m serious about getting into shape and losing weight, I just need to do it.

From a financial perspective, it would be hard to call 2011 anything but a success, but with a broader view I haven’t done much to change my life for the better this year. If 2011 was the year for focusing on my business, 2012 will be the year to focus on myself. In a few days, I’ll post a year-end look at my finances which will include numbers and other details, and after that, I’ll present my goals and resolutions for 2012.

Did you reach your goals and complete your resolutions for the year?

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Year End Reminder: Fund Your IRA Now

This article was written by in Investing. 1 comment.

These last few weeks in December present a good time to prepare your finances for the coming year. My personal goal is to start January 1 on a good note, moving my life forward. In the grand scheme putting your finances in order takes a back seat to cleaning up your life as a whole, but it’s an important task because it can set you up for financial success. I’ve suggested changing your 401(k) contribution level early and donating to charity. It’s also a good time to fund your Roth (or traditional) IRA.

Usually, the reminder to fund your Roth IRA comes in March or April. The deadline isn’t until your tax return is due in the following year. For example, I have until April 16, 2012 to transfer money into my IRA and have the contribution count towards my 2011 limit. But why wait?

When investing for retirement, you can choose between two approaches. You can contribute to retirement accounts in a lump sum investment or you can use periodic investments (often called dollar-cost averaging) to spread your contribution over a longer period of time. You can also use a combination of the two approaches. For most savers, the choice comes down to cash flow.

Choose between lump-sum and periodic investments

Dollar-cost averaging, or using the same dollar amount to purchase a theoretically different amount of shares of investment regularly, can help smooth out the short-term volatility in stock prices. When compared to investing a lump sum, with periodic investments, you’ll sometimes invest when the prices of the stocks or funds are higher, and sometimes invest when the prices are lower. It’s one way to mitigate a small amount of risk. If your options are between dollar-cost averaging and saving up to invest in a lump sum later, thanks to the general long-term trend of an increasing overall value of stocks, you’ll generally be better off in the end using periodic investments.

That’s because it’s generally to invest what you can as early as you can. This is why many people choose periodic investments. Cash flow plays a large role in determining how a family or individual will invest. Unless you’re borrowing money to invest into retirement — a dangerous proposition — chances are good you won’t have $5,000, the IRA contribution limit for people under age 50, ready to go on January 1. The first day of the year is also the first day you can contribute to the new year’s IRA.

It can take a while to save up $5,000, so if you can spread the contribution over twelve months at $416.66 per month, now is a great time to configure your coming year’s investment strategy on your IRA plan’s website. If you don’t have an IRA yet, you can start one at any discount brokerage. I use Vanguard, but Fidelity is also good, and TIAA-Cref offers the benefit of very low investment minimums. All allow you to configure periodic electronic investments from your bank account.

If you haven’t invested in this year’s IRA yet and you don’t have the cash available to invest in one lump sum, create periodic investments that help you invest as much as you can budget for between now and the April deadline.

On the other hand, you might have cash available. If so, fund this year’s IRA up to the limit now, and prepare to fund next year’s IRA soon after December 31, both in lump sums. There’s a chance that you won’t get as good a price on your investment as you would the day before or the day after, but if you’re investing for the long-term, the difference between days should be much less influential on your financial success than market performance leading up to the day you begin withdrawing and the period of time to follow.

Choose between traditional and Roth IRAs

While the laws could change at any time, traditional and Roth IRAs have a few differences. In general, if you believe you’ll be in a lower tax bracket than you are now and you qualify for the tax deduction with the traditional IRA, that would be a better option. That’s particularly the case if you don’t have an employer-sponsored retirement plan such as a 401(k). On the other hand, if you’re already receiving the tax advantage of a 401(k), and you believe you could get a better tax advantage by taking a deduction in retirement because you expect to be in a higher tax bracket, the Roth IRA might be a better choice.

Of course, you can hedge your bets by splitting your contribution between the traditional and Roth IRAs. If, however, you earn enough money, you might not qualify for a Roth IRA.

You can use this IRA contribution wizard at Mint.com to determine which IRA is best for your particular situation.

Just do it

Keep in mind that with a long-term view, a lump sum investment is preferable, if you can invest that lump sum right away. If cash flow is a concern, set up a periodic investment to invest smaller amounts over time. Every major brokerage can support this hands-off, automated approach. Saving up to invest is a last resort. If you are not enamored with the idea of investing in the stock market right now, you can always choose a safer investment, even a money market fund or a certificate of deposit. Regardless, the sooner you get invested, the better for your future finances.

Don’t wait for the deadline; for the most part, people who consistently invest the maximum on the first day (January 1 of the coming year) will be better off than those who wait to invest the maximum on the last day (usually April 15 of the following year), because those who wait miss 15 and a half months of potential growth.

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Year End Reminder: Donate to Charity

by Flexo
Charity Box

The year is quickly coming to a close, and the first priority for many people right now is getting through the holidays with as little stress as possible. Focusing solely on the holidays at the expense of your household’s financial needs can only add to stress later, so it might help to get a few ... Continue reading this article…

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The Best Credit Cards, May 2012

by Flexo

With hundreds of credit cards available today, it’s difficult to find the best credit card for your particular situation. Whether you need a travel rewards card or a great cash-back card, the best offers are getting more difficult to find. The best credit cards of 2012 are just not as rewarding as they once were, ... Continue reading this article…

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Capital One Cash Credit Card Review

by Flexo

Even though cash back rewards programs have increased over the years, they’ve also become much more complex. When a credit card issuer decides to offer more than 1 percent cash back, the company usually does it in a convoluted way that few consumers take the time to understand. Some require specific purchases to be made while ... Continue reading this article…

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Podcast 113: The Money Couple, Scott & Bethany Palmer

by Flexo

Today’s guests on the Consumerism Commentary Podcast are Scott and Bethany Palmer, also known as The Money Couple. The Money Couple talks about many topics in their book, First Comes Love, Then Comes Money: A Couple’s Guide to Financial Communication such as financial infidelity, money personalities and how couples can better understand each others’ money ... Continue reading this article…

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